As mentioned in the introduction to this section, even when mechanisms are in place enabling charter schools to issue bonds or to benefit from proceeds generated by tax credits, such as QZABs, many lenders continue to see these education institutions as risky investments. This perception can lead to steep premiums associated with facilities financing in the form of high interest rates or to unwillingness to lend—period.47 As touched on earlier, among the primary factors eroding investor confidence are
charter schools' relatively short operating histories thus far; the potential for cash flow problems (e.g., state aid payments can be delayed; also, schools usually have to sign a multiyear lease, yet, because student aid generally is calculated annually, a school cannot be certain in advance what level of aid it will receive from year to year); charter schools' inherent risk for nonrenewal or closure; and their lack of taxing authority.48 To mitigate such concerns, states can
make policy aimed at enhancing the creditworthiness of charter schools by providing lenders with some level of backup security. A variety of "credit enhancement" approaches undertaken by states to increase charter schools' capacity to raise private sector capital are discussed below.

Including Charter Schools in General Obligation Bonds

One of the strongest existing forms of credit enhancement for charter schools—but also one of the most rarely used approaches—is when a state or local government includes charter
schools in general obligation bonds. Although this credit enhancement approach remains uncommon, two states—California and Colorado—have programs allowing charter schools to benefit from tax-exempt general obligation bond proceeds.

As explained by Katrina Johantgen, executive director of the California School Finance Authority, in 2002, California established the Charter School Facilities Program (CSFP) to provide revenue for the construction or rehabilitation of charter school facilities. In providing state funds, the CSFP offers only half of what a school needs, requiring that the school seek
a match, usually in the form of a loan, for the other half. The program itself offers such loans at a relatively low interest rate. CSFP was initially funded with revenue from a large, state-level, voter-approved general obligation bond issue for general education facilities, and it subsequently has received additional revenue with the passage of two other state ballot propositions.49 Since its inception, the program has been funded with $900 million earmarked for
charter school facilities.

According to Johantgen, CSFP was modeled after the state's School Facility Program, which is an application-based grant program for traditional
public schools. But she cautions that the CSFP is challenging to navigate, especially for schools that do not have an expert with knowledge of facilities or finance readily at hand. Through the CSFP, charter schools that
provide site-based instruction (as compared to schools offering distance learning courses) may apply for these bond funds. Those schools deemed by the California School Finance Authority to be financially sound are
eligible for state facility funding, with preference given for numerous factors, including whether the school serves a low-income population
or operates in an overcrowded district. Projects are granted funds on a per-pupil basis at a level set annually by the State Allocation Board, though they must raise or borrow funding to match state facilities aid.

Yet even in combination with the 50 percent match, program awards almost never fully cover a school's construction costs, according to Caprice Young, president and chief executive officer of the California Charter Schools Association. This means most schools must piece together other funding as well. Because there are also many complications associated
with these funds, charters have struggled to use them. To start with, the law is not clear about who has the right to title during construction,
which can make it difficult to obtain construction insurance. What is clear, however, is that once CSFP-funded facilities have been completed, the district in which they are located holds title to them. Without the title to serve as collateral, charter schools have greater difficulty securing supplemental financing from commercial lenders.

In addition, two other major challenges are associated with these funds. First, CSFP funds cannot be used for predevelopment costs, such
as site-acquisition studies. Another challenge is that accessing these state funds requires interaction with at least seven state agencies and advisory
bodies.50 Young estimates that the lag time involved in garnering the necessary approvals from these agencies adds roughly three years to the timeline for completing a new facility.
The program is structured to reserve the funds awarded to schools for four years, with the possibility of a one-year extension. So CSFP funds
are "on hold" during the period when charter schools seek approvals (e.g., construction permits, certifications that sites are free of toxic substances, authorization that space meets standards of adequacy for classroom instruction), according to Barbara Kampmeinert, project management supervisor at California's Office of Public School Construction. Unfortunately, the delays associated with securing the necessary
approvals can interfere with the schools' ability to acquire other financing.

The fiscal year 2008-09 budget analysis from California's Legislative Analyst's Office suggests that the bulk of funds appropriated for the CSFP
remain unspent. Only about 12 percent of the $400 million appropriated from propositions passed in 2002 and 200451 appeared to have been utilized as of February 2008, and none of the funds from an approved 2006 proposition had been apportioned at that time. However, Kampmeinert reports that about $463 million out of the $500 million in funds appropriated
through the 2006 measure were awarded (and thus reserved) for 29 projects as of the end of May 2008. She also points out that her office
"wouldn't necessarily expect the funds to be spent at this time." Kampmeinert explains that there is still time for many of the projects
awarded in prior years that have not yet received their full apportionments to garner the approvals necessary to access the rest of their funds. In fact, she says, the program was designed to allow adequate time for a school to obtain all necessary approvals.52 According to Kampmeinert, the per-pupil grant amounts that charter schools received under the 2004 proposition were $5,870 for elementary students, $6,214 for middle school students, and $8,116 for high school students.53 But no matter what the specific funding amounts have been, Kampmeinert notes, the advent of charter schools being allotted portions of general
obligation bond issues is itself a significant policy development.

Although at least one Colorado school district included a charter school in a bond election prior to passage of the state's Charter School
Capital Facilities Financing Act of 2002, this legislation established as state law a charter school's ability to submit a capital construction
plan to be included in a school district's general obligation bond issue. Jim Griffin, president of the Colorado League of Charter Schools (League), says that while Colorado districts have the right to reject a charter school's request to be included, six districts have already included
charter schools' requests in successful bond elections. Table 4 on p. 32, a funding summary provided by Griffin, shows that the state's charter schools had received $55 million of these proceeds as of spring 2008. (In the summer of 2008, Griffin reported that a number of sizeable districts in the metropolitan Denver area were planning to seek voter approval for bond funds in fall 2008 and charter schools intended to seek inclusion in six district bond requests. A follow-up exchange with Griffin after the election revealed that only two districts that sought bond funding on the November ballot had included charter schools in their request, and only one of them had received voter approval.)

Another stipulation of the 2002 legislation, he says, is that when districts reject such proposals from charter operators, the operators may place a separate ballot question for a vote on their school's behalf. As of spring 2008, five such requests had failed at the ballot box, according
to Griffin.

The Colorado League did not initially seek the statutory ability for charter schools to be included in district bond elections. Rather, says
Griffin, its goal during the 2002 legislative session was to seek a large influx of grant funds for charter school facilities. It was only after
representatives from state and local education agencies argued that charter schools should have to seek voter approval for funding, just
as districts do, that the League conceived of the Charter School Capital Facilities Financing Act.

Allowing Access to Moral Obligation Bonds

Another credit enhancement option, a step short of including charter schools in general obligation bonds, is to give them access to moral obligation bonds. A moral obligation is a pledge made by a government entity, which is not legally binding, stating that it will repay the bond debt in the event the borrower defaults. These bonds are commonly issued to finance projects considered to be in the public good, such as hospital construction. For some local and state governments, the appeal of this financing approach is that it allows them to avoid any existing debt limits (e.g., some states are legally prohibited from acquiring debt and, therefore,
from issuing general obligation bonds) or to avoid the voter approval process required for general obligation bonds. For charter schools, which do not have access to general obligation bonds, moral obligation bonds offer the next best alternative, even though these bonds tend to be rated lower than general obligation bonds and, therefore, are more expensive for the borrower. Although these bonds are not considered as safe as general obligation bonds, according to Griffin, if a state legislature, for example, gave an issuer permission to offer the bonds under the state's "moral obligation," the legislature would likely honor any request to cover a default, appropriating funds to make good on outstanding bond payments. To do otherwise would invite investor mistrust, making it highly
unlikely that anyone in the state could issue moral obligation bonds in the future.

Colorado is the only state thus far to make a moral obligation provision available for charter school financing.54 The provision, established in
2003, attaches to select bonds the state's pledge that, in the event of a default, the governor will request that the state legislature appropriate
funds to pay debt service. Only bonds rated "investment grade" are eligible to attach Colorado's moral obligation pledge.55 The Colorado Educational and Cultural Facilities Authority (CECFA) accepts financing applications into this moral obligation program based on the representation of a school's investment banker that the school will obtain the required investment grade rating. The CECFA's bond counsel requires evidence of this rating before bonds
are issued on behalf of charter schools. As is the case with all moral obligation pledges, the bonds are not legally guaranteed by the state.
But in the event of a default, if the state did not make good on the debt, there could be a substantial negative effect on its credit.

All participants in the moral obligation program are required to utilize the intercept mechanism, described below. (Other eligible charter schools
that issue bonds may choose whether to have their debt service intercepted.) As of April 2008, Colorado's moral obligation pledge has been
attached to over $317 million in bond financing for 24 charter schools, according to CECFA's Jo Ann Soker, who says that as of spring 2008,
there had been no defaults on moral obligation bonds. Griffin indicates that participating charter schools have found the moral obligation provision to be effective in lowering interest
rates.

Offering Intercept Mechanisms

A more prevalent state approach to credit enhancement is creation of an intercept mechanism, which allows a state to divert a charter school's per-pupil revenue and transmit it directly to bondholders for debt-service payments. For investors who might worry about not getting payment from a charter school, this is a very straightforward mechanism intended
to raise their comfort level when lending to charter schools.56 Several states have intercept mechanisms that can be utilized for servicing bonds (and other facilities debt). Respondents from two of those states interviewed for this
project, Colorado and Michigan, describe the benefits to charter schools that take advantage of this credit feature.

Colorado's intercept program was initiated for charters in 2003. The state treasurer performs intercepts only for charter schools that receive
enough state aid "to cover the entire annual amount of the principal and interest payments" on any bonds issued.57 This provision ensures that the treasurer is not liable for any additional funds that may be owed but are not being received. According to CECFA's Soker, to date, 54 percent of bond issues for Colorado charter schools have had funds in the intercept program (specifically, 41 charters have used the intercept program, 24 of them as a contingency of their participation in the state's moral obligation
program. Some qualifying charter operators opt not to take advantage of the state intercept program because they prefer to have control of
their own funds. The Michigan Public Education Facilities Authority (MPEFA) also intercepts state per-pupil aid and makes the payments on bonds for all charter schools issuing bonds through the agency.

Respondents from both states note that the intercept mechanisms give lenders greater confidence that they will receive their promised debt payments, which, in turn, translates into more favorable financing terms for charter schools. MPEFA's Kathy O'Keefe says competitive rates on bonds
issued through the agency are available in large part because her organization can intercept state aid. Jim Griffin of the Colorado League of Charter Schools says that using the state's intercept mechanism helps charter schools enhance their credit ratings because, in part, it assures investors that charter schools will not misuse funds. He likens it to an employer "intercepting" an employee's paycheck to send his or her mortgage payment directly to the bank holding the employee's mortgage: "It's one more step to make the bank feel better about their probability of getting paid. [Using an intercept mechanism] won't save a charter from going under. There are probably some other things that can
still go wrong, but at least it means that the charter won't spend the money that they need to be sending to the [bond] trustees."

Funding a Debt-service Reserve

An additional policy alternative for mitigating the risk of investing in charter schools is establishment of a pool of capital that, rather than
being loaned out, is maintained as a "reserve," set aside to satisfy debt service in the event of payment default.58 Both Michigan and Texas have developed this type of reserve for charter school financing, using grant funds received through the U.S. Department of Education's Credit Enhancement for Charter School Facilities program (Credit Enhancement). According to state respondents, the programs have helped reduce charter schools' borrowing costs on bond financing.

In 2007, Michigan Public Education Facilities Authority (MPEFA) received $6.5 million in these federal Credit Enhancement grant funds, and it has put these monies into a reserve fund that guarantees the bonds it issues to finance charter school facilities.59 Further funding this reserve is $5 million in state-appropriated funds, which
come with fewer restrictions. The state funds were first appropriated in 1999, before MPEFA was created, for a loan reserve fund to facilitate
capital or operational loans to charter schools. When MPEFA was established, it also received the authority to manage these funds, and it
opted to invest the $5 million and use part of the earnings from the investment to augment the debt-service reserve fund. Initially, it used
some of the investment earnings for a short-term cash flow program for charter schools that it also administers. But when the agency received
the federal Credit Enhancement grant, Michigan adopted a policy committing all of these earnings to the charter facilities debt-service
reserve fund. The reserve is funded for the full life of the bonds it is used to secure (which are typically 20- to 30-year transactions).

Similarly, the Texas Public Finance Authority (TPFA) Charter School Finance Corporation entered into a consortium agreement with the
Texas Education Agency (TEA) and the Resource Center for Charter Schools to operate the Texas Credit Enhancement Program (TCEP).60 TCEP utilizes a $10 million federal Credit Enhancement grant for a debt-service reserve fund guaranteeing
eligible tax-exempt bonds issued on behalf of charter schools for facilities. The TEA also has contributed $100,000 for this reserve fund. The
statutory authorization for the fund was established in 2001 through state legislation,61 but TCEP was not funded until the TPFA received the federal grant in 2005. In addition, initially,
to qualify for the reserve fund, bonds had to be issued through the TPFA, but the statute was amended in 2007 so that it could be used to
guarantee any eligible bond issue in the state. As of June 2008, the TCEP supported approximately $217 million of bonds issued on behalf of charter schools.

Clarifying Charter Schools' Public Nonprofit Entity Status

Legal clarification—in charter school legislation, or charter school contracts, or both—that charter schools carry all of the powers of a public nonprofit entity is another avenue for enhancing
their credit potential.*. States that have such protective language that clarifies charter schools' ability to incorporate as public nonprofits and,
therefore, to sue, can help protect schools from any arbitrary and potentially unfair decision by an authorizer (e.g., a politically motivated decision not to renew a school's charter). Validating schools' authority to sue their authorizers also can attract investors to charter schools because
it reduces the chance that a charter would be revoked or not renewed without due process.

Colorado also has been a leader in this area through ratification of an amendment that clarifies the public entity status of the state's charter
schools and includes language regarding their capacity to sue. Under this amendment, Colorado charter schools have clear authority to enforce their contracts through litigation against their authorizers (the vast majority in
Colorado being school districts). For example, if an authorizer were to revoke or not renew a school's charter, the charter school could sue
the authorizer. Jim Griffin explains that the underlying intent of these clarifications was to make charter schools more financeable.

*Nonprofit entities are agencies, organizations, and institutions given tax-exempt status. These entities may be public or private. Public entities are typically
state or local governments or agencies, organizations, or institutions under public supervision.